Cost basis reflects the true cost of purchasing a financial asset held over an extended period of time. The longer a stock or other asset is held, the higher the probability that the original purchase price will need to be revised in order to reflect adjustments such as future purchases, stock splits, and dividend payments.
For assets purchased in several transactions, the initial cost basis is the average cost from all transactions. If a stock splits, the original cost basis is adjusted downwards. For example, in a two-for-one split the new cost basis is the old cost basis divided by two. A reverse stock-split, where the number of shares outstanding is decreased, will also increase the cost basis. Cost basis can also increase if a dividend is reinvested. In this case, the cost basis goes up to reflect the increased investment. Using an incorrect cost basis can have significant tax implications as it affects the calculation of taxable profits. |
